Fear, Selloff Fuel Bond Market Crisis

“At this rate, we could see some asset management companies failing. If investors’ confidence is shaken and they take out their capital by the bulk, the whole industry could go down.” These woeful words come from an insider at an asset management firm.

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The market for Money Market Funds (MMF), mutual funds that invest in short-term debt instruments, is being thrown into confusion.

It saw an outflow of more than 13 trillion won in just fifteen days, by business day calendar. MMF balance shrunk from 78.126 trillion won on June 7 to 65.085 trillion won on June 27, according to Asset Management Association of Korea.

As companies rushed to sell bonds in order to meet their clients’ redemption demands, prices have plummeted for short-term bonds such as certificate of deposit (CD).

The falling prices are scaring investors who want to take out more capital, leading to a vicious circle of bond prices plunging even deeper.

One asset management company has seen its MMF balance of 2 trillion won run dry due to the unending list of clients who want their money back.

“A sense of business ethics is disappearing,” goes the lament, as some financial houses even pass around damaging information on competing firms in order to absorb the capital flowing out of MMF.

The industry is also concerned that the MMF market confusion could lead to an overall distrust of the asset management sector, as was the case with the past credit card debt crisis, rocking the whole financial market as a result.

Panic Selling Creates MMF Market Upheaval-

The apparent reason for the MMF market disorder is the “following day purchasing system” scheduled to take effect from next month.

The new system was designed to make the market healthier, by setting the standard price of investment in an MMF as the bond price of not the same day, as it is now, but of the day after subscription.

The problem is that this would dip the earnings ratio a little for investors, as they would receive one day’s less of interest payments. The revised rule also complicates accounting processes.

These reasons, however, are not likely to be the major causes of the recent uproar over MMF.

Experts point out instead that the biggest factor is actually panic selling by investors.

As one after another forecast of higher interest rates (meaning lower bond prices) came out, corporate clients who had been wanting to get out of MMF anyhow finally began to pull out their short-term capital en masse before the following day purchasing system goes into effect.

When clients ask to redeem their investments, asset management firms must pay them back by selling short-term bonds they hold such as CDs. As demands for redemption are lining up, offers for CD sales have surged, dragging bond prices even lower in a vicious circle.

Rumors Abound as Financial Companies Get Nasty-

Clients can deposit or withdraw money freely from an MMF, and corporate customers mainly use it to invest reserve funds on a very short-term basis.

More clients have taken out their capital as bond prices have plunged, but no one is sure where the money will flow from there.

In order to direct it their way, asset management firms are battling each other fiercely, spreading malicious stories trying to play each other down.

All kinds of rumors abound, such as “Company A will be destroyed with a few more redemption calls,” or “Company B clients should withdraw their money immediately to reduce their losses.”

However, the asset management firms with the most investments being redeemed lately are large outfits that do not deal heavily in MMF and which are managing funds relatively well.

“It’s the nature of this market that when one company goes down, another one will grow from taking in its capital,” explained one fund manager from the industry. “There will be more attempts to bring others down in order to survive.”

Another fund manager expressed the concern that while negative propaganda could benefit a few companies right now, it could make more investors withdraw their money if they lose confidence in asset management as a whole, resulting in a total collapse of the industry.

Wan-Bae Lee roryrery@donga.com